Monday, February 16, 2015

Apple's Car and Barriers to Entry

               The rumor that Apple is considering entering the car business is one more example of a central issue this blog has addressed repeatedly regarding the valuation of Tesla (and other technology companies as well.)  There is a tendency to think that if a technology is fundamentally disruptive the companies that develop and exploit that technology will be huge creators of value.  Not necessarily so.
               One warning in this regard comes from Warren Buffett.  Consider one of the great disruptive technologies of the 20th century – the airplane.  Mr. Buffett notes that while the airplane dramatically changed the lives of most Americans, from an investment standpoint had it been at Kittyhawk he would have attempted to shoot the Wright Brothers down.  Mr. Buffett goes on to observe that despite all the benefits provided by air travel, investors in the airline industry (including Mr. Buffet) have almost uniformly under performed the market and frequently lost money outright.
               The problem is one that economists have recognized for centuries – competition.  Remember that in a perfectly competitive market producers create no new value.  They only earn their cost of capital.  Creating value requires keeping competition out.  Creating fortunes requires keeping competition out for a long time.  Technology is not a particularly good tool in this regard.  Yes, the innovations associated with it open doors, but those doors are opened to competitors as well.
               To return to Tesla, current competition and potential future entry are why Professor Damodaran and I have argued that Tesla’s current valuation is rich and that a valuation of Tesla comparable to Apple’s is ridiculous.  The automobile market is simply too competitive.  The entry of Apple, if it occurs, is just another example of that.  It is also worth adding that one should not assume that if Apple enters it will necessarily be a boon for the company for precisely the same reason.  Apple will not be immune from competition, including, ironically, competition from Tesla.  The bottom line is that the future of the automobile industry looks great from the standpoint of consumers, but not necessarily from the standpoint of investors.  Airlines 2?

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